Monday, September 17, 2012

The Wonderfulness of Inflation

Paul Krugman is still advocating the wonderfulness of inflation. In a New York Times editorial today he is being critical of those who decry Ben Bernanke, because while he says that the most recent Fed policy is “far from being a panacea for the economy’s troubles,” it is “still a welcome move.” His language is a little confusing, as his language usually is, because he seems to rather thoroughly despise Ben Bernanke but is forced to defend the actions that Bernanke is taking.

One of the hopeful results he foresees is that, “potential home buyers will be encouraged by the prospect of moderately higher inflation that will make their debt easier to repay.”

Economists are really fond of that thought, but I have never figured out why the fact that gasoline went up to $4.67 per gallon, or hamburger to $3.95 per pound, is going to make my mortgage easier to pay. That “inflation will make debt easier to pay” is possibly one of the most idiotic things I have ever heard economists say.

Rising wages would make my mortgage easier to pay and, sitting there in their ivory towers, economists probably make an assumption that wages always rise along with inflation, in which case they should say that “Rising wages which accompany inflation would…” But there are several flies in that ointment. The first is that wages don’t always rise with inflation, or they rise at amount which is lower than the rate of inflation.

The next problem is that the inflation upon which raises are based, and upon which the Social Security cost of living increase is based, do not include food and energy and are therefor often less than real inflation in terms of what people have to spend in order to live. That makes a mortgage harder to pay, not easier, because even though my income rose, I’m having to spend a higher portion of my income on food and energy.

Finally, even when the income increase does match real inflation, that additional income is taxed at a higher rate due to our tax system, which is not as progressive as it should be but is not a flat tax. The first $3800 of a person’s income is not taxed at all, the next $8500 is taxed at 10%, etc. The portion of income which is the increase may be taxed at a rate as high as 33% under the present system, so increased wages after taxation is not going to make one’s mortgage easier to pay.

Let’s say that my total income tax averaged out at 14% of my gross income, but my additional income was in the 29% bracket. Then only 85% of that new income would be available to contribute to the increased cost of living caused by inflation, the other 15% of that increase would have to come out of my preexisting income, and my mortgage payment is now harder to make.

There is simply no way that “moderately higher inflation will make debt easier to repay” unless one receives an increase in income which is significantly higher than that inflation, an event which is unlikely in the extreme. Even if it did happen, it was the higher income which made the mortgage easier to repay, not inflation.

What higher inflation will do is make savings worth less money, so that when savers pull that money out of savings and spend it, that money will by less in the way of goods and services. Inflation punishes people who save money.

1 comment:

bruce said...

It never made sense to me why anyone would NOT include food and energy in the inflation index. These are very real, very significant costs. Maybe it's just ivory tower thinking, or "lets hide the true facts and make people feel better" sort of thing.

I know what Mr. Krugman is getting at, but inflation doesn't make things go away or make things cheaper in and of itself. And there is a price to pay for that, savings are worth less is just one.

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